Draghi and EU Energy Derivatives Trading

The Draghi Report seeks to increase the competitiveness of European industry by, amongst others, lowering energy costs and securing energy supply. The report therefore includes, for example, proposals for greening of the energy supply side and a reduction in the energy demand side. Although only a small part of the substantial report, it also includes recommendations as regards the regulation of energy derivatives markets. Financial regulation, however, serves a different purpose. As my recent article sets out in more detail, it is a mechanism to safeguard, where necessary, the proper functioning of the energy derivatives markets, and not a tool for lowering energy prices or to secure energy supply.

A Flutter of EU Policy Initiatives

The Draghi Report was the major starting point for the new European Commission at the end of last year. The report rightly notes that high energy prices in the EU are decreasing its competitiveness. Since the reduction in import of Russian gas following the war in the Ukraine, and the closure of the large gas field in Groningen, the EU has become increasingly dependent on purchasing LNG in a volatile and competitive global market. Many of the policy initiatives presented in the Draghi Report thus relate to reshaping the energy supply- and demand side. However, there are also a number of recommendations for the regulation of EU energy (derivatives) markets, noting ‘fundamental issues’ with the market itself. Financial and behavioural aspects as well as market concentration are alleged to push up energy prices and volatility. 

As the new European Commission is seeking to implement the Draghi Report, it has presented various follow-up plans, including the Clean Industrial Deal, the Action Plan for Affordable Energy, and the establishment of the Gas Market Task Force (GMTF). As part of the Action Plan, under ‘Action 3’, the GMTF should ‘comprehensively scrutinise the EU natural gas markets and, where necessary, take action to ensure their optimal market functioning and prevent commercial practices distorting market-based pricing, learning from the lessons of the energy crisis [in summer 2022]’. The work is to be concluded by the fourth quarter of 2025.

Barking Up the Wrong Tree

Regrettably, not all the regulatory measures proposed by the Draghi Report have the potential to improve energy derivatives markets. Some of them may simply not add anything above and beyond the current regulatory framework, such as the implementation of more circuit breakers. Recent measures have already been implemented to this effect, including the strengthening of Art 48 MiFID II (via Directive 2023/790/EU as part of the MiFIR Review), as well as a targeted ESMA supervisory briefing, and a new Regulatory Technical Standard 7A on the requirements on circuit breakers. 

Other measures, such as price caps, would likely even be detrimental: the introduction of the Market Correction Mechanism (MCM), the dynamic price cap introduced in the wholesale gas markets following summer 2022, has received much criticism both from ESMA and ACER as well as from academia—including my article last year. In particular, the European Agencies find that there is no evidence indicating that the lowering of prices levels following the summer of 2022 can be attributed to the MCM—and are attributable to changing supply and demand instead. To the contrary, various risks emanating from the MCM are highlighted, including trading moving potentially from the EU to the UK, or from on-venue to OTC, as well as risks to financial stability upon activation of the MCM relating to clearing and to retaining fair and orderly markets.

Another set of proposals, such as the location of trading and amending the Ancillary Activity Exemption (AAE, as per Art 2(1)(j) MiFID II), directly concerns the regulation of market participants. A location requirement would likely demand those trading in EU energy markets to have an actual presence within the EU, rather than trading from offices in London or Geneva. Currently, there is only a requirement under Art 9(1) REMIT (as amended by Regulation (EU) 2024/1106 REMIT II) to designate a representative in the Member State in which these third country market participants are active. The other proposal concerns the AAE, which provides a relief from MiFID-authorisation for those market participants, such as ‘ordinary’ firms, for whom trading energy derivatives is merely a way to hedge their risks as a (smaller) part of their overall business as usual activities. Narrowing the scope of the AAE would likely result in non-financial firms requiring authorisation with all the consequences thereof, at best placing them at a disadvantage in comparison with their non-EU peers. These proposals therefore have the likely outcome of discouraging non-EU market participants, whilst restraining and locking EU market participants in the remaining, less liquid, EU market.

Every Cloud has a Silver Lining

Whilst the above may appear to be rather critical, there certainly is room for improvement within the current regulatory framework. Two areas stand out: regulatory reporting and supervisory cooperation. As regards the former, reporting to regulators could be streamlined and perhaps centralised, whereas increased visibility on OTC positions would be welcome. As for the latter, further and deeper coordination between European and national authorities, both in spot- and derivatives markets, could lead for example to a more complete picture in surveillance. Overlapping or unclear mandates are another point at issue. 

Furthermore, alongside the Draghi proposals, there is also the European Commission’s recent consultation under Art 90(5) MiFID II on commodity and energy derivatives markets. Taking into consideration a broad range of responses from industry, regulators, stakeholder groups etc. the outcome of this consultation might provide a more holistic and pragmatic overview on what changes are actually needed and warranted.

Simplification and Burden Reduction

It is not difficult to spot potential legislative inefficiencies in the regulatory framework. There is an overlap between ‘wholesale energy products’ under REMIT II and ‘financial instruments’ under MIFID II. Moreover, various provisions from both MAR (eg, on insider trading and market manipulation) and MiFID II (eg, as regards algorithmic trading) have been duplicated into REMIT II. Surely these overlaps and duplications are not the most efficient approach. Moreover, and perhaps somewhat bemusedly, none of the aforementioned EU policy initiatives appear to be overly concerned with, for example, increasing depth and liquidity in these markets which would allow EU (energy) firms to hedge their risk cheaper and more efficiently. A suggestion would be to shift the focus on building, expanding and improving the current energy markets, stimulating innovation, rather than regulating even further.

In summary, the Draghi Report makes various proposals on regulating energy (derivatives) markets, some of which are rather unpalatable—and perhaps most of the regulatory framework is best left largely as it is. Yet it should be recognised some improvements can be made, both in the regulatory supervisory and the reporting framework, as well as towards the inefficiencies in the overlapping legislation. Small and targeted legislative changes appear to be the best way forward.

Ebbe Rogge is an Associate Professor at the Leiden University, Netherlands, and a Senior Policy Advisor for the Dutch Authority for the Financial Markets. The opinions expressed herein are solely those of the author and in no way represent those of the Dutch Authority for the Financial Markets.